Very bad news for the US?

I know very little about foreign currency exchange but the way I read this article it really seems like China is starting to move to undermine one of the key pillars of US dominance, the Dollar as the world reserve currency.

Tony Comments:

Actually the general gist of it is correct (Zero Hedge is a great source of information like this). There's not a lot you can do when the biggest lender to you decides you're probably not a good prospect for paying it back, and in this case the writing's been on the wall for a good, long while.

China really doesn't have an incentive to keep financing the US (or the West in general) apart from allowing us to maintain a level of consumerism that buoys their manufacturing. Another reason mentioned in the article is that they need to maintain a stockpile of dollars since they're pegged to it so it makes sense on their end to maintain confidence in it. That being said, no one really believes the west is going to get their houses in order. We've seen small bailouts in the Eurozone but Spain has a potential to really wreck things beyond anything we've seen and no one seriously thinks the US will be fiscally responsible any time soon. For the Chinese, that has historically meant that the dollar is a refuge of last resort but they've known (and said publicly) that given their wealth and manufacturing strength that the yuan should be valued higher which is opposed to the west's wellbeing. They've staunchly refused to devalue (which would be akin to extending our line of credit) and they may continue to hold the line for a while but any chronic debtor knows that this is a dead-end for them since they continue to spend more than they take in.

In the end, this is hardly a surprise move and the effects of it are definitely bad (although I would argue that the predicament we're currently in is just as bad as it inevitably leads to this situation). There isn't really even a way out as the article points out. What will happen as the Chinese reduce debt holdings is that the yuan will be undervalued more and their portfolio grows more robust (less risk + strong capital reserves). As that occurs it will be more and more attractive to move to the yuan as a "reserve currency" as it will be backed by real wealth. While I don't see them moving to float the yuan any time soon (it would destroy the dollar and their primary market), a firm, graduated schedule for higher valuation is almost a certainty which will put great inflationary pressure on the dollar which will drive holdings from dollars to yuan quickly.